Bloomberg News

Europe’s Junk Bonanza Helps LBO Firms Cut Loans: Credit Markets

January 31, 2013

Europe’s Junk Bonanza Helps LBO Firms Cut Loans

Five-year contracts on Chesapeake debt dropped 67.8 basis points to 389.2 basis points, the lowest since December 2011, Bloomberg prices show. Photographer: Matt Nager/Bloomberg

European junk-bond sales are off to the busiest start on record as companies owned by private-equity firms such as Permira Advisers LLP and Doughty Hanson & Co. take advantage of plummeting yields to repay loans.

The region’s neediest borrowers have issued $17 billion of speculative-grade bonds this month, according to data compiled by Bloomberg. That’s 38 percent more than the previous high of $12.3 billion in January 2011. Odigeo Group, an online travel company co-owned by Permira, repaid 315 million euros ($427.3 million) of loans by selling notes, the data show.

Investors are snapping up European junk bonds as the region’s debt crisis subsides and central banks globally keep interest rates at unprecedented lows, helping speculative-grade borrowers tackle the more than $352 billion of loans due from 2014 as banks pare lending, Fitch Ratings said. Demand for junk bonds also may trigger a rebound in European leveraged buyouts, which fell more than 30 percent last quarter to $15.7 billion.

“PE firms’ switch to high-yield bonds from loans is a reaction to the relative attractiveness of debt instruments in today’s market,” Max Biagosch, the London-based head of Permira’s financing group wrote in an e-mail. Borrowers are also looking to alternative funding sources because bank loans are likely to decrease in the next few years, he said.

Banks Retreat

European lenders are selling assets and reducing lending, needing to more than triple the core capital they hold under new standards from the Basel Committee on Banking Supervision. Companies in the region owned by buyout firms raised $70.9 billion of loans last year, less than the $73.7 billion in 2011, Bloomberg data show. That’s the fifth straight year that the amount of such loans decreased.

“The deleveraging of the European banking system is the fundamental factor raising doubt over the ability of many legacy leveraged borrowers to meet their refinancing requirements,” Edward Eyerman, head of Fitch’s London-based European leveraged finance team, wrote in a December report.

Elsewhere in credit markets, a gauge of U.S. corporate credit risk increased the most in a month after the economy unexpectedly shrank in the fourth quarter. Credit-default swaps on Chesapeake Energy Corp. fell to the lowest level in more than 13 months after the company said Chief Executive Officer Aubrey McClendon would retire. KKR & Co.’s First Data Corp. sold $785 million in bonds and raised $258 million in loans to refinance debt.

Swap Spreads

The U.S. two-year interest-rate swap spread, a measure of debt-market stress, increased 0.03 basis point to 15.91 basis points. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.

The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, increased 3.9 basis points to 90.2 basis points, according to prices compiled by Bloomberg.

Gross domestic product dropped at a 0.1 percent annual rate, weaker than any economist forecast in a Bloomberg survey and the worst performance since the second quarter of 2009, when the world’s largest economy was still in the recession, Commerce Department figures showed yesterday in Washington. A decline in government outlays and a smaller gain in stockpiles subtracted a combined 2.6 percentage points from growth.

Chesapeake Bonds

The Markit iTraxx Europe Index of 125 companies with investment-grade ratings added 2.5 to 113.5 at 9:50 a.m. in London. The Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan climbed three to 114.

The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Five-year contracts on Oklahoma City-based Chesapeake’s debt dropped 67.8 basis points to 389.2 basis points, the lowest since December 2011, Bloomberg prices show. Chesapeake lost as much as 43 percent of its market value in 2012 as scrutiny of McClendon’s financial transactions destroyed investor confidence in management and cratering gas prices drained the company of cash.

Bonds of Goldman Sachs Group Inc. (GS:US) were the most active dollar-denominated corporate securities yesterday, accounting for 3.6 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

First Data

First Data, the credit-card processor acquired by KKR in September 2007 that’s lost money every quarter since the buyout, sold 11.25 percent, eight-year notes that yield 987 basis points more than Treasuries of similar maturity, Bloomberg data show.

The term loan, due 2018, will pay interest at 5 percentage points more than the London interbank offered rate with no floor, according to a person with knowledge of the transaction. First Data sold the loan at par, said the person who asked not to be identified because the information is private.

In emerging markets, relative yields widened 4 basis points to 261 basis points, or 2.61 percentage points, according to JPMorgan Chase & Co.’s EMBI Global index. The index ended last month at 265.8.

Exiting CLOs

Junk-rated borrowers in Europe also face a shrinking market for collateralized loan obligations. Only two new CLOs have been issued in the last four years, down from a 2007 peak of 35 billion euros, Bloomberg and Fitch data show.

Existing CLOs will also see their role reduced with JPMorgan estimating that $53 billion of the funds will exit their reinvestment periods in the next two years. This means the funds must start using interest payments received on loans they hold to pay off investors rather than buy debt.

CLOs pool high-yield, high-risk loans and slice them into securities of various risk and return. The funds account for the largest group of non-bank buyers of the debt in the region, according to JPMorgan.

Junk bonds in Europe have been rallying as confidence in the region’s ability to tame its debt crisis increases. European Central Bank President Mario Draghi said in July that the bank will do what it takes to preserve the euro, sparking a jump in speculative-grade bonds that reduced their yields to a record of 5.3 percent on Jan. 11, Bank of America Merrill Lynch data show. The debt yielded 9.6 percent at the start of 2012.

‘Bullish Sentiment’

Leveraged loans and high-yield, high-risk bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s.

For companies owned by buyout firms, the average interest paid above benchmark rates for loans has increased to 475 basis points in 2012 from 422 basis points in 2011, Bloomberg data show. With loans remaining relatively more costly than notes, more borrowers may turn to the bond market for financing.

“We expect a large amount of leveraged corporates to become bond issuers in 2013, making Europe more like the U.S. market,” said Henrik Johnsson, head of European High Yield Capital Markets at Deutsche Bank AG in London. “The bullish sentiment on mid-term European growth and low financing costs will allow more M&A activity. We are currently working on a record number of large LBO transactions.”

CVC Capital Partners Ltd., a private equity firm, raised 780 million euros of high-yield bonds earlier this month to back its buyout of Cerved Group SpA, an Italian business credit information provider.

Repaying Loans

Odigeo, owned by Axa Private Equity and Permira Advisers LLP, sold 325 million euros of 7.5 percent notes on Jan. 23 to repay 315 million euros of term loans, according to bond documents obtained by Bloomberg.

Doughty Hanson, the London-based buyout firm, has tapped the junk-bond market three times since November to refinance the loans of its companies, Bloomberg data show. In the latest debt sale, Zobele Holding SpA, an air care and insecticide devices supplier which counts Procter & Gamble Co. as its client, issued 180 million euros of 7.875 percent bonds on Jan. 24 to repay 166 million euros of loans.

“The driver behind sponsors switching into bonds is the strength of the demand, with market appetite for high-quality paper, both fixed and floating rate,” Nick Bastin, a London- based spokesman for Doughty Hanson, said in an e-mailed statement.

‘Future Impairment’

Using high-yield bonds to repay loans may provide private- equity firms with more time to reduce debt at companies they own and turnaround their businesses while equity financing remains weak. Initial public offerings in 2012 raised $112 billion globally, the least since 2008, Bloomberg data show.

“Ideally, LBOs created equity value both by growing the company and by debt reduction from free cash flow,” said Peter Aspbury, a high-yield investor at JPMorgan Asset Management, which oversees $1.4 trillion. “High-yield bond refinancings often highlight the inability of the company to pay down debt or of the sponsor to achieve a profitable exit. If the sponsors can’t create equity value, then the risk of future impairment for creditors grows.”

To contact the reporter on this story: Patricia Kuo in London at pkuo2@bloomberg.net

To contact the editor responsible for this story: Faris Khan at fkhan33@bloomberg.net


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